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Belated slump in US equities, while US Treasury rates are pushing lower; JPY and the USD are well supported in this environment; NZD slipped below 0.66 overnight while the AUD shredded its post-RBA gains

Currencies
Belated slump in US equities, while US Treasury rates are pushing lower; JPY and the USD are well supported in this environment; NZD slipped below 0.66 overnight while the AUD shredded its post-RBA gains

The escalation of US-China trade tensions is in focus, driving a risk-off session, with a belated slump in US equities, while US Treasury rates are pushing lower. JPY and the USD are well supported in this environment.  NZD slipped below 0.66 overnight while the AUD shredded its post-RBA gains.

The S&P500 opened 0.7% lower and is currently down over 2%, in a belated reaction to the escalation of US-China trade tensions.  Yesterday morning, US trade representative Lighthizer confirmed that tariffs on $200b of Chinese imports would rise to 25% starting 12:01am on Friday, citing a reneging on prior commitments by China.  He added that high-level talks with Chinese negotiators were expected to continue Thursday and Friday in Washington. Late yesterday, China confirmed that its top trade negotiator, vice-premier Liu would head to Washington for talks, while sources suggested that it is preparing retaliatory tariffs to follow any lift in US tariffs.

While there’s a chance that Trump’s threat of increased tariffs can be averted, the odds of a deal at the end of the week have significantly fallen, meaning another hit to global growth as tariffs are ratcheted higher while trade negotiations play out – this could be months, or even into next year as one report has suggested. Up until last week, markets had been pricing in a trade agreement as close to a “done deal” so any further bad news here raises the chance of a lot further downside for risk assets as risk appetite tumbles.

Price action in the bond market has been well-contained – so far – with the US 10-year rate down only 2bps to 2.45%.  The Fed’s more hawkish outlook last week might be a factor here.  In a Bloomberg TV interview, Fed vice-Chair Clarida pushed back on the need for rate cuts, suggesting that current policy will get inflation back to the 2% target, supporting Chair Powell’s view at the post-FOMC press conference last week. 

In other news, German factory orders rose for the first time in three months, but the recovery was smaller than expected. The European Commission cut its growth forecasts for the euro area, slashing its 2019 forecast for Germany from 1.1% to 0.5%, and warned that escalating trade tensions threaten to make the outlook even worse. These factors, alongside lower risk appetite, have pushed Germany’s 10-year rate down 4bps to minus 0.04% and dragged EUR lower.

In the risk-off environment, JPY is the strongest of the majors, seeing USD/JPY down to 110.20. The USD is also well supported, with the USD indices up in the order of 0.2%.

The AUD is back down to 0.70, losing all the gains it saw after the RBA decided to leave the cash rate unchanged at 1.5% in what was expected to be a close call.  The peak was close to 0.7050 within minutes of the announcement, but it has been a steady slide since. While no rate cut was delivered, the market is taking the view that it is only a matter of time, with the August meeting well-priced for a cut.  The RBA kept its rose-tinted glasses on, seeing a recovery in growth and inflation. An implicit easing bias remains in play, with the Bank needing to see a further improvement for inflation to be consistent with the target.  The market doesn’t see this happening, so sees rate cuts being delivered. The 3-year bond future showed an implied 9bps rise in yield on the announcement, but that has since pared back to 5bps.

The NZD saw some positive spillover on the RBA announcement, touching 0.6630, before coming to the same fate as the AUD.  NZD/AUD has pushed down to 0.9420. The risk-off backdrop of USD support saw the NZD slip below 0.66 overnight, but it found some support around 0.6590. The GDT dairy auction showed a small increase in pricing, its 11th consecutive rise, broadly in line with expectations of a flat result.

The focus today turns to the RBNZ Monetary Policy Statement at 2pm, where 14 out of 20 economists surveyed by Bloomberg expect a 25bps cut in the OCR to 1.5%. Over the past couple of sessions, OIS pricing for the meeting has drifted out to 1.65%, suggesting that, on balance, the market is slightly weighted towards an unchanged rate today.  Pricing falls away through to early next year, with some 42bps of easing priced into the curve.  This sets the scene for a market reaction, no matter what the Bank does.  Price action post the RBA announcement is instructive.  No rate cut would see some temporary upward pressure on the NZD, but the sustainability of any upside in question with the US-China trade war backdrop.  The path of least resistance on a rate cut is for a weaker NZD, although given current market pricing any forward policy guidance will need to be accounted for.  Similarly, rates will rise on a no-change decision, but moderated to the extent that this would most likely reflect a timing issue and the market would likely keep future rate cuts priced in.

While NZD/JPY is down 0.7% to 72.7 as risk appetite has soured, the NZD has managed to hold its ground on EUR and GBP crosses.  The soft backdrop for EUR is noted above, while GBP has lost some support as sources are pointing to a likely impasse on cross-party talks between the Conservatives and Labour to come to an agreement on Brexit, even as PM May’s office says that cross party talks today have been constructive. The odds of a second referendum on Brexit seem to be rising by the day.


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